High Court Pulls Rug from Investor Protections

The High Court changed the ground rules for all investors in framing its judgment in the Fortescue v ASIC case. Protections investors had assumed have vanished.

The decision handed down by Australia's High Court in the case of Forrest v Australian Securities and Investments Commission [2012] HCA 39 followed an appeal by corporate watchdog ASIC against an earlier Federal court decision in favour of high profile mining entrepreneur and Fortescue Metals Group director John Andrew "Twiggy" Forrest.

The guts of the ASIC complaint against Forrest and Fortescue Metals Group was that they had attributed more certainty to a commercial agreement with putative Chinese-based partners than was reasonable. In short, the company said it had a "binding agreement" when it did not. Moreover, according to the ASIC complaint, directors knew the agreement was not binding.

Putting aside the question of whether Forrest had broken any laws, two aspects of the findings by Australia's most eminent jurists stand out.

Firstly, the judges advanced the idea that there is no such thing as a binding agreement. The judges cautioned that use of the words "contract" and "agreement" should not be taken to convey a message about legal enforceability in an Australian court. That, they said, "is too broad a proposition".

They argued that "there was no evidence" that a court would grant any relief in the event that one party or other would not carry out its part of the contemplated bargain. The judges observed more generally that "it is in fact extraordinarily difficult for the state to 'force' anyone to do anything".

Based on this view, one could easily conclude that a company claiming to have a binding agreement is telling legal porkies. A company claiming to have a binding agreement would, in fact, be claiming an attribute that did not exist, according to the judges.

Of course, there might be exceptions. Specific provisions in agreements or unusual circumstances might make an agreement enforceable but, it seems, the onus must be on a company to demonstrate the peculiar qualities of any agreement it has entered into. Otherwise, it cannot claim it is binding.

So, if there is generally no such thing as a binding agreement, doesn't it make sense that a director claiming to have a binding agreement should be hauled before the courts? No; not according to the judges.

In the second aspect of its judgement, the court has said that a binding agreement may not have existed where one was claimed but this would have been seen by investors for what it was so cannot be construed as misleading.

Investors might have been excused for thinking that the rules about continuous disclosure had offered some protections against claims that were dressed up to promote a higher share price, for example. ASIC must have thought so, too. Otherwise, it would not have laid the charges against Fortescue in the first place.

However, the High Court has apparently put the kibosh on this naive view of the protections the continuous disclosure rules can offer.

There is a generally accepted (as well as legal) distinction between what are usually referred to as sophisticated investors and those who, by broad agreement, have a lesser familiarity with investment markets or who might have a different risk profile and who should only buy an investment after seeking advice.

The High Court has trampled over this distinction with hobnailed boots. It has referred to investors, without exception, as being "tough, shrewd and sceptical".

The judges explicitly included "smaller investors reliant on advice" in describing the target audience who would have known better than to accept an announcement at face value (or assume that regulatory protections would come to their aid).

The absurdity of this proposition is mitigated only by the fact that it is propagated by judges of the High Court.

The idea that investors are uniformly "tough, shrewd and sceptical" or that all investors are sufficiently "tough, shrewd and sceptical" to forensically cut through the spin companies routinely employ to promote their share prices runs contrary to much of the financial services regulatory framework, if not plain common sense.

Absurd though it may be, this view of the world and the capacity of investors to assimilate information is effectively the new law of the land.

So, beware. Do not buy a stock thinking that ASIC will be able to drag a director into court if the director claims to be doing something that cannot be done.

The new investment risk is that any lower court will defer to the High Court's view that an investor should have been sufficiently "tough, shrewd and sceptical" to have seen through the subterfuge.

Further than that, the court would say, even if you were not of such a mind you should have been.

Until ASIC can back another case to test whether the High Court actually wanted to turn Australia's capital markets into a seedy backstreet bazaar, all financial advisers should be aware that their clients have fewer rights now than they thought they did barely a month ago.

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